What is the Difference Between Factoring and Reverse Factoring?

Reverse Factoring – The Win-Win Financial Solution for Each Link in the Supply Chain

Reverse Factoring or Supply Chain Financing is when a bank or finance company commits to pay a company’s invoices to the suppliers at an accelerated rate in exchange for a discount. It is unlike traditional invoice factoring, where a supplier wants to finance his receivables. Reverse factoring is a funding solution started by the ordering party to help his supplier finance their receivables easily. Typically at a lower interest cost than what factors normally offer.

Factoring is a financial transaction. It is a kind of debtor finance in which a business sells its invoices to a third party (called a factor) at a discount. A company will sometimes factor its receivable assets to meet its present and fast cash needs. It might also factor their invoices to mitigate credit risk. Several people also refer to Factoring as accounts receivable factoring, invoice factoring, and sometimes, erroneously, accounts receivable financing.

Not a loan and different from factoring your accounts receivable, supply chain financing an alternative funding source for supplier finance. Supply chain financing is advantageous to every party affected in a manufacturing and distribution supply chain.

For businesses that deal with the distribution and sale of manufactured goods, there could be a long line of suppliers before you reach a finished product. That supply chain gets kinked when one of the links becomes inefficient, whether that be the fault of a supplier or the receiver of goods. Supply chain financing can help work out those supplier finance knots.

What is Supply Chain Financing?

Supply Chain Financing is a financing solution initiated by the ordering party to help his supplier finance their receivables quickly and typically at a lower interest cost than what would usually be offered.

Picture this; you are a watch manufacturer with many parts coming from numerous sources. The band is from a plant in Brazil. The face comes from China. Finally, the inside mechanism is shipped from Switzerland. Once the production of each piece is complete, it is forward to a manufacturing plant in Germany. From there, they are assembled to form a watch before being boxed up and shipped to your distributor.

However, there is trouble in China. The plant has run out of working capital to complete the production of the watch faces. In getting the money to finish the job, they sell your invoice to an alternative lending company. The factoring company then gives them the cash needed to complete the task. The watch dealer is still going to pay the same price for the faces, and the face supplier in China is only going to lose a small fee paid to the lender.

More importantly, the faces arrive on time to the German manufacturing plant, so there are no hold-ups in production. Despite the many links making up this supply chain, reverse factoring ensures that the distributor can start selling the watch when promised, despite whatever problems were happening at the supply plant in China.

How Does Supply Chain Financing Differ from Invoice Factoring?

At first glance, trade finance may seem like an elaborate version of invoice factoring or invoice discounting. However, there are two significant differences. The watchmaker would use invoice factoring for working capital after having billed his distributor for shipping the finished product. An unpaid bill backs the money that is advanced with invoice factoring for goods or services already received while it is the expectation of a finished product that is supporting supply chain financing.

The difference is not just in the timing of the transaction, but also with who is getting the funds. The money received from a traditional factoring company is going to the manufacturer of the whole product to help with their cash flow. In reverse factoring, it is one of the smaller suppliers who is getting the boost so that they can continue their operations. You and your vendor suppliers also receive payable management, longer terms, order financing, and many other supplier benefits.

How is Supply Chain Financing Beneficial for Everyone?

Supply chain financing ensures that all parts of the manufacturing process can stay in sync. A delay in the production impacts the final sale of the product and could cost the manufacturer money from loss of sales. By receiving the payment ahead of time, the supplier can deliver on their portion of the chain efficiently. Plus, without any additional cost to the buyer. Although they are charged a fee for the cash advance, this is small in comparison to what the price would be if they were to default on the commitment to produce entirely.

Reverse Invoice Factoring Transaction Explained

The manufacturer can sell unpaid supplier invoices to an alternative business lender after negotiating the terms of when to pay those invoices. The lender will then advance the cost of that invoice to the supplier, deducting their fee in the process. It allows the manufacturer to wait for payment from their distributors before having to pay for the parts and services used to make their product. It speeds up the payment process dramatically, allowing production to continue while invoices are still outstanding.

Is Supply Chain Financing a Loan?

A business loan is a financial product that provides you with financing in one lump sum, which you are expected to pay back with regular payments plus interest. There is no interest added to the money advanced with supply chain financing. Also, payment for the money is in full as soon as the customer pays the invoice. The receiver of the funding is not borrowing money, but rather receiving the funds that are not yet due to them early.

By taking advantage of reverse factoring, you are not putting your business into any debt. You are getting a flow of working capital to continue to function and meet your customers, vendors, and employee’s needs. It is an ideal alternative to the traditional bank loan. Not only because you are not increasing your debt, but because it is typically easier to obtain the money.

Who is Using Reverse Factoring?

Manufacturers and suppliers across all sectors can take advantage of supply chain financing. Large automotive parts, electronics suppliers, clothing wholesalers, and more are all able to benefit from this low-cost financing method. Since both the buyer benefits from being able to extend their payment terms and the supplier is receiving payment earlier. It has become a preferred method of financing for both sides of the manufacturing chain.

Supply chain financing is worth looking into, no matter which link of the chain you are. Providing a low-cost way to influx suppliers with cash, supply chain financing is helping thousands of manufactured products reach their destination on time.

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